Long Term Agreements

Email from Anton Kotze of Ellipsis regarding some info on the CPA and contracts.

Hi

Mohammad – Thanks for insights into a very interesting thread.

All of the parties are correct to some extent. I have some legal and some commercial input, and the two inputs work together in tandem.

With regards to the legal input, it is indeed correct that consumers (being any individual person or any company with a turnover/asset value of less than R2million) can indeed terminate a fixed term agreement as provided for in the CPA, subject to the right of the service provider to charge a reasonable fee. The reasonable fee is expanded on in regulation 5(2) of the regulations published under the act in GNR.293 of 1 April 2011. Although there is no formula, there is 10 factors that needs to be taken into consideration, namely:

(a)the amount which the consumer is still liable for to the supplier up to the date of cancellation;
(b)the value of the transaction up to cancellation;
(c)the value of the goods which will remain in the possession of the consumer after cancellation;
(d)the value of the goods that are returned to the supplier;
(e)the duration of the consumer agreement as initially agreed;
( f )losses suffered or benefits accrued by consumer as a result of the consumer entering into the consumer agreement;
(g)the nature of the goods or services that were reserved or booked;
(h)the length of notice of cancellation provided by the consumer;
(i) the reasonable potential for the service provider, acting diligently, to find an alternative consumer between the time of receiving the cancellation notice and the time of the cancelled reservation; and
( j) the general practice of the relevant industry.

The CPA and its regulations then also needs to be read with the Conventional Penalties Act of 1962 (incidentally also abbreviated to CPA :)). In short, the Conventional Penalties Act provides that penalty clauses for early termination is valid and enforceable. However in terms of section 3 of the act a court may reduce a claim for such a penalty amount if it is found that claim is out of proportion to the prejudice suffered.

To understand the prejudice suffered, one must also understand the business model of the service provider and the justification for requiring fixed term contracts. A few that I can think of is as follows, and more often than not these issues are cumulative:

1. Often, there is capital outlay in the form of CAPEX underpinned by a business case which requires a certain level of income. There may also be a need for CAPEX to grow the network.
2. As customer increase, so does operational requirements, albeit not in direct correlation. For example the need to increase support staff and maintenance agreements. Such commitments are normally much more difficult to reduce that the potential rate at which customer revenue can reduce.
3. Often, especially when contracting for larger “core” capacity – the service provider itself has to enter into longer term agreements to get better pricing so as to make it more competitive.
4. Businesses with month-to-month contracts will be valued much lower than business with term based income. Term based contracts therefore serves to increase the value of the company whilst mitigating against risks.
5. On the point of risk, this is something that in terms of the King III code of governance requires to be considered and mitigated within the boundaries of the companies’ risk appetite.
6. Term contracts are often used as an incentive for the customer to obtain better pricing.

Risk
Customers always blame the connectivity provider for everything that they do across the link, because they don’t understand that sometimes it is not the quality of the link but the quality of the application that they are using it for, or the quality of remote servers on third party networks. This is especially true in the consumer, low priced market where the level of consumer technical knowledge is not so great. This thus means that you can have customer cancelling agreements for reasons that are not attributable to you, but for which you are blamed for reasons which are not manageable by you. You therefore run the risk that due to factors outside of your control your revenue can decrease at a much faster rate than your expidenture. This in turn reduces overall profit margins and creates cash flow problems. In addition, planning for growth is much more difficult and risky if you do not have a pipeline of guaranteed income.

All of the above, (and I’m sure these much more) therefore serves to create prejudice to the service provider in an environment where customers can cancel at short notice.

Fixed term agreements, carefully and properly structured within the parameters of the business model of the service provider and within the context of “risk-v-reward” therefore serves to create a win-win scenario for both service provider and customer and conversely, if it was structured for a win-win and the customer does not honour it, then the service provider will suffer prejudice.